retirement Retirement is the withdrawal from one's position or occupation or from one's active working life. A person may also semi-retire by reducing work hours or workload. Many people choose to retire when they are elderly or incapable of doing their j ...

, individuals stop working and no longer get employment earnings, and enter a phase of their lives, where they rely on the

assets In financial accounting, an asset is any resource owned or controlled by a business or an economic entity. It is anything (tangible or intangible) that can be used to produce positive economic value. Assets represent value of ownership that can b ...

they have accumulated, to supply money for their spending needs for the rest of their lives. Retirement spend-down, or withdrawal rate, is the strategy a retiree follows to spend, decumulate or withdraw assets during retirement.

Retirement planning Retirement planning, in a financial context, refers to the allocation of savings or revenue for retirement. The goal of retirement planning is to achieve financial independence. The process of retirement planning aims to: *Assess readiness-to-r ...

aims to prepare individuals for retirement spend-down, because the different spend-down approaches available to retirees depend on the decisions they make during their working years.

Actuaries An actuary is a professional with advanced mathematical skills who deals with the measurement and management of risk and uncertainty. These risks can affect both sides of the balance sheet and require asset management, liability management, ...

and

financial planner A financial planner or personal financial planner is a qualified financial advisor. Practicing in full service personal finance, they advise clients on investments, insurance, tax, retirement and estate planning. As a general rule, a financial p ...

s are experts on this topic.

Importance

More than 10,000

Post-World War II baby boom The middle of the 20th century was marked by a significant and persistent increase in fertility rates in many countries, especially in the Western world. The term ''baby boom'' is often used to refer to this particular boom, generally considered t ...

ers will reach age 65 in the United States every day between 2014 and 2027. This represents the majority of the more than 78 million Americans born between 1946 and 1964. As of 2014, 74% of these people are expected to be alive in 2030, which highlights that most of them will live for many years beyond retirement. By the year 2000, 1 in every 14 people was age 65 or older. By the year 2050, more than 1 in 6 people are projected to be at least 65 years old. The following statistics emphasize the importance of a well-planned retirement spend-down strategy for these people: *87% of workers do not feel very confident about having enough money to retire comfortably. *80% of retirees do not feel very confident about maintaining financial security throughout their remaining lifetime. *49% of workers over age 55 have less than $50,000 of

savings Wealth is the abundance of valuable financial assets or physical possessions which can be converted into a form that can be used for transactions. This includes the core meaning as held in the originating Old English word , which is from an ...

. *25% of workers have not saved at all for retirement. *35% of workers are not currently saving for retirement. *56% of workers have not tried to calculate their income needs in retirement.

Longevity risk

Individuals each have their own retirement aspirations, but all retirees face

longevity risk A longevity risk is any potential risk attached to the increasing life expectancy of pensioners and policy holders, which can eventually result in higher pay-out ratios than expected for many pension funds and insurance companies. One important ...

– the risk of outliving their assets. This can spell financial disaster. Avoiding this risk is therefore a baseline goal that any successful retirement spend-down strategy addresses. Generally, longevity risk is greatest for low and middle income individuals. The probabilities of a 65-year-old living to various ages are: Longevity risk is largely underestimated. Most retirees do not expect to live beyond age 85, let alone into their 90s. A 2007 study of recently retired individuals asked them to rank the following risks in order of the level of concern they present: *

Health care Health care, or healthcare, is the improvement or maintenance of health via the preventive healthcare, prevention, diagnosis, therapy, treatment, wikt:amelioration, amelioration or cure of disease, illness, injury, and other disability, physic ...

costs *

Inflation In economics, inflation is an increase in the average price of goods and services in terms of money. This increase is measured using a price index, typically a consumer price index (CPI). When the general price level rises, each unit of curre ...

Investment Investment is traditionally defined as the "commitment of resources into something expected to gain value over time". If an investment involves money, then it can be defined as a "commitment of money to receive more money later". From a broade ...

risk *Maintaining lifestyle *Need for long-term care *Outliving assets (longevity risk) Longevity risk was ranked as the least concerning of these risks.

Withdrawal rate

A portion of retirement income often comes from savings, sometimes referred to as a nest egg. Analyzing one's savings involves a number of variables: * how savings are invested (e.g., cash, stocks, bonds, real estate), and how this changes over time * inflation during retirement * how quickly savings are spent – the ''withdrawal rate'' Often, an investor will change some of their investment types as one ages. A common strategy to replace more risky investments with less risky investments as one gets older. A "risky" investment is an investment that has a higher potential return but also a higher potential loss. A "conservative" investment is an investment with a low potential return but a lower potential loss. A number of approaches exist to assist with choosing the correct risk level, for example,

target date fund A target date fund (TDF), also known as a lifecycle fund, dynamic-risk fund, or age-based fund, is a collective investment scheme, often a mutual fund or a collective trust fund, designed to provide a simple investment solution through a portfol ...

s. A common

rule of thumb In English language, English, the phrase ''rule of thumb'' refers to an approximate method for doing something, based on practical experience rather than theory. This usage of the phrase can be traced back to the 17th century and has been associat ...

for withdrawal rate is 4%, based on 20th century American investment returns, and first articulated in . Bengen later stated the 4% guideline was intended as a "worst case scenario" for retirees in United States, using a hypothetical example of someone who retired in 1968 at a stock market peak before a protracted

bear market A market trend is a perceived tendency of the financial markets to move in a particular direction over time. Analysts classify these trends as ''secular'' for long time-frames, ''primary'' for medium time-frames, and ''secondary'' for short time ...

and high

inflation In economics, inflation is an increase in the average price of goods and services in terms of money. This increase is measured using a price index, typically a consumer price index (CPI). When the general price level rises, each unit of curre ...

through the 1970s. In that scenario, a 4% withdrawal rate allowed the investor's funds to last 30 years. Historically, Bengen says closer to 7% is an average safe withdrawal rate and at other times withdrawal rates up to 13% have been feasible. A 4% withdrawal rate is also one conclusion of the

Trinity study In finance, investment advising, and retirement planning, the Trinity study is an informal name used to refer to an influential 1998 paper by three professors of finance at Trinity University in the US. It is one of a category of studies that atte ...

(1998). This particular rule and approach have been heavily criticized, as have the methods of both sources, with critics arguing that withdrawal rates should vary with investment style (which they do in Bengen) and returns, and that this ignores the risk of emergencies and rising expenses (e.g., medical or long-term care). Others question the suitability of matching relatively fixed expenses with risky investment assets. New dynamic adjustment methods for retirement withdrawal rates have been developed after Bengen's 4% withdrawal rate was proposed: constant inflation-adjusted spending, Bengen's floor-and-ceiling rule, and Guyton and Klinger's decision rules. More complex withdrawal strategies have also been created. To decide a withdrawal rate, history shows the maximum sustainable inflation-adjusted withdrawal rate over rolling 30-year periods for three hypothetical stock and bond portfolios from 1926 to 2014. Stocks are represented by the S&P 500 Index, bonds by an index of five-year U.S. Treasury bonds. During the best 30-year period withdrawal rates of 10% annually could be used with a 100% success rate. The worst 30-year period had a maximum withdrawal rate of 3.5%. A 4% withdrawal rate survived most 30 year periods. The higher the stock allocation the higher rate of success. A portfolio of 75% stocks is more volatile but had higher maximum withdrawal rates. Starting with a withdrawal rate near 4% and a minimum 50% equity allocation in retirement gave a higher probability of success in historical 30 year periods. The above withdrawal strategies, sometimes referred to as strategic withdrawal plans or structured withdrawal plans, focus only on spend-down of invested assets and do not typically coordinate with retirement income from other sources, such as Social Security, pensions, and annuities. Under the actuarial approach described below for equating total personal assets with total spending liabilities to develop a sustainable spending budget, the amount to be withdrawn from invested assets each year is equal to the amount to be spent during the year (the spending budget) reduced by income from other sources for the year.

Sources of retirement income

Individuals may receive retirement income from a variety of sources: *Personal savings and interest *Retirement savings plans (i.e., individual retirement account (United States), Registered Retirement Savings Plan (Canada)) *

Defined contribution plan A defined contribution (DC) plan is a type of retirement plan in which the employer, employee or both make contributions on a regular basis. Individual accounts are set up for participants and benefits are based on the amounts credited to these a ...

s (i.e.,

401(k) In the United States, a 401(k) plan is an employer-sponsored, defined-contribution, personal pension (savings) account, as defined in subsection 401(k) of the U.S. Internal Revenue Code. Periodic employee contributions come directly out of their ...

403(b) In the United States, a 403(b) plan is a U.S. tax-advantaged retirement savings plan available for public education organizations, some non-profit employers (only Internal Revenue Code 501(c)(3) organizations), cooperative hospital service organiz ...

, SIMPLE,

457(b) The 457 plan is a type of nonqualified, tax advantaged deferred-compensation retirement plan that is available for governmental and certain nongovernmental employers in the United States. The employer provides the plan and the employee defers com ...

, etc.) *

Defined benefit pension plan Defined benefit (DB) pension plan is a type of pension plan in which an employer/sponsor promises a specified pension payment, lump-sum, or combination thereof on retirement that depends on an employee's earnings history, tenure of service and a ...

s *

Social Insurance Social insurance is a form of Social protection, social welfare that provides insurance against economic risks. The insurance may be provided publicly or through the subsidizing of private insurance. In contrast to other forms of Welfare spend ...

(i.e.,

Canada Pension Plan The Canada Pension Plan (CPP; ) is a contributory, earnings-related social insurance program. It is one of the two major components of Canada's public retirement income system, the other being Old Age Security (OAS). Other parts of Canada's retir ...

, Old Age Security (Canada), National Insurance (United Kingdom),

Social Security (United States) In the United States, Social Security is the commonly used term for the federal Old-Age, Survivors, and Disability Insurance (OASDI) program and is administered by the Social Security Administration (SSA). The Social Security Act was passed ...

) *Rental income *Annuities *Dividends *Sale of assets to provide income *

Tontine A tontine () is an investment linked to a living person which provides an income for as long as that person is alive. Such schemes originated as plans for governments to raise capital in the 17th century and became relatively widespread in the 18 ...

s *Work during retirement Each has unique risk, eligibility, tax, timing, form of payment, and distribution considerations that should be integrated into a retirement spend-down strategy.

Modeling retirement spend-down: traditional approach

Traditional retirement spend-down approaches generally take the form of a gap analysis. Essentially, these tools collect a variety of input variables from an individual and use them to project the likelihood that the individual will meet specified retirement goals. They model the shortfall or surplus between the individual's retirement income and expected spending needs to identify whether the individual has adequate resources to retire at a particular age. Depending on their sophistication, they may be

stochastic Stochastic (; ) is the property of being well-described by a random probability distribution. ''Stochasticity'' and ''randomness'' are technically distinct concepts: the former refers to a modeling approach, while the latter describes phenomena; i ...

(often incorporating

Monte Carlo simulation Monte Carlo methods, or Monte Carlo experiments, are a broad class of computational algorithms that rely on repeated random sampling to obtain numerical results. The underlying concept is to use randomness to solve problems that might be det ...

) or deterministic. ''Standard input variables'' *Current age *Expected retirement date or age *

Life expectancy Human life expectancy is a statistical measure of the estimate of the average remaining years of life at a given age. The most commonly used measure is ''life expectancy at birth'' (LEB, or in demographic notation ''e''0, where '' ...

*Current savings *Savings rate *Current salary *Salary increase rate *

Tax rate In a tax system, the tax rate is the ratio (usually expressed as a percentage) at which a business or person is taxed. The tax rate that is applied to an individual's or corporation's income is determined by tax laws of the country and can be in ...

Inflation rate In economics, inflation is an increase in the average price of goods and services in terms of money. This increase is measured using a price index, typically a consumer price index (CPI). When the general price level rises, each unit of curre ...

Rate of return In finance, return is a profit on an investment. It comprises any change in value of the investment, and/or cash flows (or securities, or other investments) which the investor receives from that investment over a specified time period, such as i ...

on investments *Expected retirement expenses ''Additional input variables that can enhance model sophistication'' *Marital status *Spouse's age *Spouse's assets *Health status *Medical expense inflation *Estimated social security benefit *Estimated benefits from employer sponsored plans *

Asset class In finance, an asset class is a group of marketable financial assets that have similar financial characteristics and behave similarly in the marketplace. These instruments can be distinguished as either having to do with real assets or having ...

weights comprising personal savings *Detailed expected retirement expenses *Value of home and

mortgage A mortgage loan or simply mortgage (), in civil law (legal system), civil law jurisdictions known also as a hypothec loan, is a loan used either by purchasers of real property to raise funds to buy real estate, or by existing property owners t ...

balance *

Life insurance Life insurance (or life assurance, especially in the Commonwealth of Nations) is a contract A contract is an agreement that specifies certain legally enforceable rights and obligations pertaining to two or more parties. A contract typical ...

holdings *Expected post-retirement part-time income ''Output'' *Shortfall or surplus There are three primary approaches utilized to estimate an individual's spending needs in retirement: *Income replacement ratios: financial experts generally suggest that individuals need at least 70% of their pre-retirement income to maintain their standard of living. This approach is criticized from the standpoint that expenses, such as those related to health care, are not stable over time. *

Consumption smoothing Consumption smoothing is an economic concept for the practice of optimizing a person's standard of living through an appropriate balance between savings and consumption over time. An optimal consumption rate should be relatively similar at each sta ...

: under this approach individuals develop a target expenditure pattern, generally far before retirement, that is intended to remain level throughout their lives. Proponents argue that individuals often spend conservatively earlier in their lives and could increase their overall utility and living standard by smoothing their consumption. *Direct expense modeling: with the help of financial experts, individuals attempt to estimate future expenses directly, using projections of inflation, health care costs, and other variables to provide a framework for the analysis.

Adverse impact of market downturn and lower interest rates

Market volatility can have a significant impact on both a worker's retirement preparedness and a retiree's retirement spend-down strategy. American workers lost an estimated $2 trillion in retirement savings during the

2008 financial crisis The 2008 financial crisis, also known as the global financial crisis (GFC), was a major worldwide financial crisis centered in the United States. The causes of the 2008 crisis included excessive speculation on housing values by both homeowners ...

. 54% of workers lost confidence in their ability to retire comfortably due to the direct impact of the market turmoil on their retirement savings.

Asset allocation Asset allocation is the implementation of an investment strategy that attempts to balance risk versus reward by adjusting the percentage of each asset in an investment portfolio according to the investor's risk tolerance, goals and investm ...

contributed significantly to these issues. Basic investment principles recommend that individuals reduce their

equity investment A stock trader or equity trader or share trader, also called a stock investor, is a person or company involved in trading equity securities and attempting to profit from the purchase and sale of those securities. Stock traders may be an inve ...

exposure as they approach retirement. Studies show, however, that 43% of 401(k) participants had equity exposure in excess of 70% at the beginning of 2008. World Pensions Council (WPC)

financial economist Financial economics is the branch of economics characterized by a "concentration on monetary activities", in which "money of one type or another is likely to appear on ''both sides'' of a trade". William F. Sharpe"Financial Economics", in Its c ...

s have argued that durably low interest rates in most G20 countries will have an adverse impact on the underfunding condition of pension funds as "without returns that outstrip inflation, pension investors face the real value of their savings declining rather than ratcheting up over the next few years" From 1982 until 2011, most Western economies experienced a period of low inflation combined with relatively high returns on investments across all

asset class In finance, an asset class is a group of marketable financial assets that have similar financial characteristics and behave similarly in the marketplace. These instruments can be distinguished as either having to do with real assets or having ...

es including government bonds. This brought a certain sense of complacency amongst some pension

actuarial Actuarial science is the discipline that applies mathematical and statistical methods to assess risk in insurance, pension, finance, investment and other industries and professions. Actuaries are professionals trained in this discipline. In m ...

consultants and regulators, making it seem reasonable to use optimistic economic assumptions to calculate the

present value In economics and finance, present value (PV), also known as present discounted value (PDV), is the value of an expected income stream determined as of the date of valuation. The present value is usually less than the future value because money ha ...

of future pension liabilities. The potentially long-lasting collapse in returns on

government bond A government bond or sovereign bond is a form of Bond (finance), bond issued by a government to support government spending, public spending. It generally includes a commitment to pay periodic interest, called Coupon (finance), coupon payments' ...

s is taking place against the backdrop of a protracted fall in returns for other core-assets such as

blue chip Blue chip may refer to: * Blue casino token * Blue chip (stock market), a corporation with a national reputation for quality, reliability, and the ability to operate profitably * Blue chip (sports), collegiate athletes who are targeted by professio ...

companies'stocks, and, more importantly, a silent demographic shock. Factoring in the corresponding

, pension premiums could be raised significantly while

disposable income Disposable income is total personal income minus current taxes on income. In national accounting, personal income minus personal current taxes equals disposable personal income or household disposable income. Subtracting personal outlays ( ...

s stagnate and employees work longer years before retiring.

Coping with retirement spend-down challenges

Longevity risk becomes more of a concern for individuals when their retirement savings are depleted by asset losses. Following the market downturn of 2008–09, 61% of working baby boomers are concerned about outliving their retirement assets. Traditional spend-down approaches generally recommend three ways they can attempt to address this risk: *Save more (spend less) *Invest more aggressively *Lower their standard of living Saving more and investing more aggressively are difficult strategies for many individuals to implement due to constraints imposed by current expenses or an aversion to increased risk. Most individuals also are averse to lowering their standard of living. The closer individuals are to retirement, the more drastic these measures must be for them to have a significant impact on the individuals' retirement savings or spend-down strategies.

Postponing retirement

Individuals tend to have significantly more control over their retirement ages than they do over their savings rates, asset returns, or expenses. As a result, postponing retirement can be an attractive option for individuals looking to enhance their retirement preparedness or recover from investment losses. The relative impact that delaying retirement can have on an individual's retirement spend-down is dependent upon specific circumstances, but research has shown that delaying retirement from age 62 to age 66 can increase an average worker's retirement income by 33%.
Postponing retirement minimizes the probability of running out of retirement savings in several ways: *Additional returns are earned on savings that otherwise would be paid out as retirement income *Additional savings are accumulated from a longer wage-earning period *The post-retirement period is shortened *Other sources of retirement income increase in value (Social Security, defined contribution plans, defined benefit pension plans) Studies show that nearly half of all workers expect to delay their retirement because they have accumulated fewer retirement assets than they had planned. Much of this is attributable to the market downturn of 2008–2009. Various unforeseen circumstances cause nearly half of all workers to retire earlier than they intend. In many cases, these individuals intend to work part-time during retirement. Again, however, statistics show that this is far less common than intentions would suggest.

Modeling retirement spend-down: alternative approach

The appeal of retirement age flexibility is the focal point of an

approach to retirement spend-down that has spawned in response to the surge of baby boomers approaching retirement. The approach is based on personal asset/liability matching process and present values to determine current year and future year spending budget data points. This self-adjusting actuarial process is very similar to the process employed by pension actuaries to help pension plan sponsors determine current and future years’ annual contribution requirements.

Similarity to individual asset/liability modeling

Most approaches to retirement spend-down can be likened to individual asset/liability modeling. Regardless of the strategy employed, they seek to ensure that individuals' assets available for retirement are sufficient to fund their post-retirement liabilities and expenses. This is elaborated in dedicated portfolio theory.

References

Plan A plan is typically any diagram or list of steps with details of timing and resources, used to achieve an Goal, objective to do something. It is commonly understood as a modal logic, temporal set (mathematics), set of intended actions through wh ...

Individual retirement accounts {{Employment